Why Greece Must Default or Restructure Its Debt

Greece will never be able to pay all it owes, and the sooner its principal creditors—the European Union, European Central Bank and International Monetary Fund—face reality, the better for everyone.

The Troika is demanding more austerity—cuts in government spending, higher taxes and labor market reforms—to release another tranche of bailout funds. Without it, Greece can’t pay €1.54 billion due the IMF on June 30.

Withdrawals from Greek banks would accelerate further, and Athens would have to impose limits on private withdrawals and on the euros investors could take out of the country.

In the panic, a broader default on Greek debt would likely follow.

A disorderly collapse of Greek finances would do few involved—or global markets—much good, but it’s foolish to believe more austerity and labor market reforms could fix Greece.

Thanks to austerity imposed since 2010, Athens has accomplished a primary national budget surplus. Spending, net of interest payments, is about 1 percent of GDP, and private sector wages have fallen some 25 percent.

Contrary to the predictions of German Chancellor Angela Merkel and IMF Managing Director Christine Legarde, those have not rekindled growth. GDP is down 25 percent and national debt has soared from 130 to 180 percent of GDP.

Servicing that debt would require a primary surplus of almost 6 percent of GDP—assuming creditors would accept a paltry 3 percent on bonds—and send Greece into a death spiral.

The required additional spending cuts and tax increases, applying conservative macroeconomic assumptions, would shrink the economy by another 6 percent. That would impel even more spending cuts, tax increases and economic downsizing.

The Greek government owes €131 billion—with the Troika holding in one form or another about €100 billion. Only forgiving half—likely more—of that debt offers any hope of stabilizing Greece, but politics and simple ignorance stand in the way.

Germany would take a big haircut on any Greek restructuring, and German voters suffer the fantasy they are rugged and industrious, whereas the Greeks are indolent and deadbeats.

Although Germany has greatly reformed the letter of its employment laws to be in step with the requirements of global competition, during the recent financial crisis Berlin paid private employers to keep huge numbers of workers on the job. It seems reforms apply only when more generous policies are not needed to keep everyone employed.

Pushing down wages hasn’t worked for Greece, because it lacks a well developed export sector in manufacturing. A good deal of its private foreign revenues flow from petroleum refining and shipping, and those are not as sensitive to movements in wages as stitching apparel and assembling iPhones in Asia. The constant fiscal crisis and uncertainly about Greek membership in the EU and tariff free access to western European markets discourages new foreign investment to exploit lower wages.

For Germany and other creditors, the only sensible options are to accept big losses on the debt they hold now or let Greece leave the euro altogether. The latter would impose losses as the Greek debt remarked in drachma fell in value as the new currency depreciated to balance Greece’s foreign payments and receipts.

The size of those losses would depend on the terms of the divorce. If Greece were permitted to remain a member of the EU without the euro, or at least continue to have tariff free access to EU markets, it would attract more foreign investment, and the drachma depreciation and creditor haircuts would be more limited than if Germany and the others insisted on banishing Greece from the EU altogether.

At some point the facts and reason must triumph, but that may require new leadership in Germany and the IMF—leaders willing to see the light of day.

Mr. Morici is an economist and business professor at the University of Maryland, and a national columnist. He tweets at @pmorici1.